Charitable remainder trusts are an exit option for commercial property owners.
In recent years, many of my clients have relayed the same
situation as they approach retirement age: They bought an investment property
20 or 30 years ago that has appreciated beyond their wildest dreams. But that’s
where the good news ends. Now that they are older or possibly even retired,
they’ve lost interest in continuing to manage the property. And, since many
retirees are on fixed incomes, the financial burden of maintaining and
repairing an investment property is more than they can comfortably afford. Many
clients would like to sell their investment properties and start enjoying their
However, selling highly appreciated investment property can
be tricky. The combined federal and state capital gains rates can be as high as
30 percent on investment property sales, which represents a large portion of
the capital retirees may want to reinvest to enhance their fixed retirement
income. Many advisers suggest their clients sell their investments and complete
a Section 1031 tax-deferred exchange. This can be a good strategy, but it puts clients
back into owning property, which many times is not the objective.
who want to retain the power of their equity and avoid capital gains taxes
should consider creating a charitable remainder trust. A specific advantage is
that CRTs can be established with an annual payout of 5 percent or more for the
duration of the client’s life. When a property is deeded to a CRT, donors
receive a significant income tax deduction -- 29 percent of the asset’s value
if both spouses are age 65, 36 percent if both are age 70, and 44 percent if
both are age 75. The deduction can be taken in the year the trust is funded or
spread out over six years to offset as much as 30 percent of their adjusted
gross income for each of those six years. In addition, the investor’s designated
charity becomes the beneficiary of the trust upon the investor’s death.
For example, if a client bought an income-producing property
for $200,000 and sold it 20 years later for $800,000, the potential capital
gains exposure could be as high as $180,000. If the client reinvested the
balance of the proceeds -- $620,000 -- at a 6 percent rate of return, the
annual yield would be approximately $37,200. If the $800,000 investment
property is put into a CRT, upon sale the proceeds within the CRT can be
reinvested in a stock and bond portfolio so that the $800,000 principal can
grow and continue to pay out at least 6 percent –- in this case $48,000 -- per
year for the remainder of the donors’ lives. With the tax deduction that can be
taken for the first six years of the trust’s duration, most of the income from the trust during that
period can be sheltered completely.
Suppose the investors determine they’d prefer the $800,000
go to heirs, such as their children. In this situation, clients could consider
buying a whole life insurance policy for $800,000 that either is owned by the
children or put into a life insurance trust. The investors make annual gifts to
the children or the trustee of the life insurance trust. The policy owner then
uses those funds to pay the annual insurance premium. When the investor passes
away, the designated charity receives the balance of the funds from the CRT and
the heirs receive $800,000 tax free from the life insurance trust.
there is an important caveat to consider when working with CRTs: This
tax-deferral structure is not suitable to property encumbered by debt. Before
engaging in a CRT, investors should consult a qualified tax professional to
discuss the various advantages and disadvantages of this tax-deferral strategy.